Seeking Inflation-Resistant Stocks

April 07, 2005

By Michael Kaye, CFA Investors' nagging fears about inflation have been building for some time now. Commodity prices -- especially those for crude oil -- have reached near-record highs in recent months. Leading measures of "core" inflation (i.e., excluding food and energy prices) at the consumer and wholesale level have ticked noticeably higher. And as if to put an official stamp on those fears, the Federal Reserve acknowledged in its Mar. 22 policy statement that "pressures on inflation have picked up in recent months."

A stepped-up rate of inflation is cause for worry for consumers, investors, and Fed policymakers. A too-rapid rise in prices for goods and services can have a debilitating effect on corporate profits and consumer spending -- and has traditionally caused the central bank to raise interest rates in response.

That sounds like a recipe for lower returns on stocks. Where can an equity investor turn if inflation is indeed gathering steam? That's what we tried to find out in this week's screen.

POSITIVE TRENDS. We believe companies with solid profit margins are in a better position to withstand inflation concerns. If a business can maintain steady levels of profitability -- or elevate them -- it's an indication that it retains pricing power in its key markets. So for our first criterion, we looked for outfits with a five-year average

net profit margin above 10%.

And we wanted to make sure that their profitability trend was generally positive, so each had to have profit margins that rose in at least four of the past five years.

Finally, we looked for stocks with S&P investment rankings of 3 STARS (hold) or greater and

S&P Fair Value rankings of 3 or higher.

When our screen was finished, these six names turned up. They're in sectors that have historically benefited when inflation picks up: energy, materials, and industrials.